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More market swings likely as budget battle looms

Worries that Washington will be unable to avoid the government spending cuts and tax increases known as the “fiscal cliff” drove the stock market to its biggest drop this year on Wednesday. On the day after, big investors warned: Prepare for more turbulence.

“Difficult times are probably far from finished for the stock market,” said Liz Ann Sonders, chief investment strategist at the brokerage Charles Schwab.

In a conference call with reporters Thursday, Sonders said the election heightened fear that Congress and re-elected President Barack Obama won’t reach a deal by Jan. 1, when the tax increases and budget cuts begin to kick in.

If they are allowed to take full effect, the cuts and tax increases will total about $800 billion in 2013. Economists say they could knock the U.S. economy back into recession.

Investors hope Congress and the president can reach a deal by mid-December, before Congress breaks for Christmas. House Speaker John Boehner said Wednesday that Republicans were ready to “find the common ground that has eluded us.”

Many big investors fret that an agreement will prove difficult because the political landscape hasn’t changed much: Obama returns to the White House, Republicans keep charge of the House and Democrats still hold the Senate.

Pessimism regarding a compromise led to more losses on Wall Street on Thursday. The Dow closed down 121.41 points to 12,811.32, bringing its two-day loss to 434 points. The Standard and Poor’s 500 index fell 17.02 points to 1,377.51 and the Nasdaq composite slipped 41.71 to 2,895.58.

“We’re going to have the same polarized dynamic that has tied Washington in knots for the last two years,” said Mike Townsend, vice president of legislative and regulatory affairs for Schwab.

Barry Knapp, the chief U.S. equity strategist at Barclays, on Thursday lowered his year-end prediction for the Standard & Poor’s 500 index by 70 points to 1,325. That is 69 points below where it ended Wednesday.

In a note to clients, the usually optimistic Knapp said the election “confirms the picture of a polarized federal government.” The major players in Washington kept their jobs, he said, “the worst outcome for the fiscal cliff negotiations.”

Some of Wall Street’s strategists take an even grimmer view. David Kostin, chief U.S. equity strategist at Goldman Sachs, has forecast the S&P 500 will hit 1,250 before the year is out.

The Dow closed down 121.41 points to 12,811.32, bringing its two-day loss to 434 points. The Standard and Poor’s 500 index fell 17.02 points to 1,377.51 and the Nasdaq composite slipped 41.71 to 2,895.58.

Sonders said more stock-market drops could push Congress and Obama into an agreement. It may look like the bruising fight over raising the government borrowing limit last year, which rocked financial markets around the world and led S&P to strip the U.S. of its top credit rating.

“I don’t think it will be as volatile as last August,” Sonders said. “We’re not going to try and game what’s going to happen. But I do think that, whatever happens, it’s going to be at the 11th hour.”

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